Seller Carryback Financing (or Seller Financing)
Seller carryback financing occurs when the seller of a property acts as the lender, providing a loan to the buyer to cover part or all of the purchase price. Instead of the buyer obtaining a traditional bank loan for the full amount, the seller accepts payments directly from the buyer over time, typically holding a promissory note and a security instrument (like a mortgage or deed of trust). This arrangement can make a property more appealing to buyers who may struggle with conventional financing, and offers sellers potential tax benefits and a steady income stream. For lenders, brokers, and investors, understanding these terms is crucial when evaluating notes for purchase or facilitating such transactions, ensuring proper documentation and servicing are in place for compliance and risk management.
Promissory Note
A promissory note is a legally binding written promise by one party (the maker or borrower) to pay a definite sum of money to another party (the payee or lender) on demand or at a specified future date. In private mortgage and seller financing, this document outlines the loan terms, including the principal amount, interest rate, payment schedule, and maturity date. It serves as the primary evidence of the debt and is essential for enforcement and sale of the loan. Proper drafting of the promissory note is critical for compliance, defining payment obligations clearly, and streamlining any potential servicing issues or transfers of the note to investors, ensuring all parties understand their financial commitments.
Deed of Trust / Mortgage
A Deed of Trust or Mortgage is a legal instrument that secures a promissory note by pledging the financed property as collateral. In many states, a Deed of Trust is used, involving three parties—the borrower, the lender, and a neutral third-party trustee who holds legal title until the loan is paid off. A Mortgage, common in other states, involves two parties—the borrower and the lender—and creates a lien on the property. Both documents are recorded in public records, establishing the lender’s lien priority. For private mortgage servicing, these instruments are vital for ensuring the lender’s security interest, guiding foreclosure proceedings in case of default, and providing clear legal standing that streamlines paperwork and protects investment.
Loan Servicing
Loan servicing refers to the administrative process of managing a loan from the time the proceeds are disbursed until the loan is fully paid off. For private mortgages, this includes collecting payments, managing escrow accounts for property taxes and insurance, handling delinquencies, responding to borrower inquiries, and maintaining accurate records. Effective loan servicing is paramount for private mortgage investors, lenders, and brokers as it ensures compliance with state and federal regulations, protects the asset’s value, and provides a professional experience for both borrower and lender. Outsourcing to a professional servicer streamlines paperwork, reduces administrative burden, and mitigates risks associated with direct handling of payments and compliance requirements.
Escrow Account
An escrow account, in the context of private mortgages, is a special fund held by a neutral third party (often the loan servicer) on behalf of the borrower and lender. Its purpose is to collect and disburse funds for recurring property-related expenses, such as property taxes and homeowner’s insurance premiums. The borrower makes regular payments into the escrow account along with their principal and interest, ensuring that these significant expenses are paid on time. For private mortgage investors and servicers, managing escrow accounts properly is crucial for compliance with RESPA and other regulations, protecting the collateral property, and simplifying financial management by consolidating payments, thereby preventing lapses in coverage or tax defaults.
Balloon Payment
A balloon payment is a large, lump-sum payment that becomes due at the end of a loan term, after a series of smaller, regular payments. This financing structure is common in private mortgage and seller financing, where the regular payments may be interest-only or amortized over a longer period than the actual loan term. For example, a loan might have payments calculated as if it were a 30-year loan but with a 5-year term, meaning the remaining principal is due in one large payment at the end of the fifth year. Lenders, brokers, and investors must clearly define and communicate balloon payment terms to ensure compliance and avoid borrower confusion or default, streamlining the eventual payoff or refinance process.
Due-on-Sale Clause
A due-on-sale clause, also known as an alienation clause, is a provision in a mortgage or deed of trust that gives the lender the right to demand immediate repayment of the entire loan balance if the borrower sells or transfers ownership of the property. This clause prevents the new buyer from assuming the existing loan without the lender’s permission and protects the lender’s interest by requiring the loan to be satisfied upon sale. In private mortgage agreements, understanding and enforcing this clause is vital for lenders and investors to maintain control over their investment, ensure proper underwriting for any new borrower, and streamline the process of either approving an assumption or receiving full payoff upon property transfer.
Land Contract (or Contract for Deed)
A Land Contract, also known as a Contract for Deed, is an alternative real estate financing agreement where the seller retains legal title to the property while the buyer takes possession and makes payments. Unlike a traditional mortgage, legal title does not transfer to the buyer until the full purchase price, including interest, is paid. This method is often used in private transactions, especially when buyers cannot qualify for conventional financing. For private mortgage servicers and investors, these contracts require diligent management, as the seller’s retained legal title means different default and foreclosure processes compared to a standard mortgage, necessitating specialized compliance and paperwork to protect both parties.
Wraparound Mortgage
A wraparound mortgage is a form of junior financing where a new loan “wraps around” an existing, underlying mortgage. The buyer makes payments to the seller (the wrap lender), who then continues to make payments on the original, underlying mortgage. The wrap loan’s interest rate is typically higher than the underlying loan’s rate, generating profit for the seller. This strategy is common in seller financing when the existing mortgage has a favorable interest rate or prepayment penalty. For private mortgage investors and servicers, managing a wraparound requires careful attention to payment collection and disbursement to the underlying lender, ensuring compliance and preventing default on the senior lien, which streamlines financial management and risk assessment.
Partial Release
A partial release is an agreement between a lender and a borrower that allows a portion of the collateral securing a mortgage or deed of trust to be released from the lien, while the remaining property continues to secure the balance of the loan. This is often used when a large parcel of land is financed and the borrower wishes to sell or develop individual lots within that parcel. For private mortgage lenders and investors, properly executing a partial release involves careful calculations to ensure the remaining collateral adequately secures the outstanding loan balance and compliance with the original loan terms. This process streamlines property development and sales while protecting the lender’s investment.
Note Investor (or Private Mortgage Investor)
A note investor, or private mortgage investor, is an individual or entity that purchases existing promissory notes and their associated security instruments (like deeds of trust or mortgages) from original lenders, often at a discount. These investors buy the right to receive future payments from the borrower, essentially becoming the new lender. This provides liquidity to original sellers and creates investment opportunities for those seeking passive income or higher yields than traditional investments. For mortgage lenders and brokers, understanding the note investor market is key for offering exit strategies to clients and ensuring all documentation is compliant and transferable, streamlining the sales process and due diligence.
Subordination Agreement
A subordination agreement is a legal document that establishes the priority of one debt over another. In private mortgage scenarios, it’s typically used when there are multiple liens on a property. For example, if a property owner with an existing private mortgage wants to obtain a new loan (perhaps for renovations), the original private lender might agree to subordinate their lien, allowing the new loan to take a first-lien position. This is a critical legal consideration for all parties, as it directly impacts the order in which creditors are paid in the event of foreclosure. Properly executed subordination agreements are essential for compliance and managing the risk profile of private mortgages.
Default Management
Default management in private mortgage servicing involves the processes and strategies employed when a borrower fails to meet their loan obligations, such as missing payments. This includes early intervention, communication with the borrower to understand their situation, implementing loss mitigation strategies like loan modifications or forbearance agreements, and initiating collection efforts or, if necessary, foreclosure. For private mortgage lenders and investors, effective default management is critical for protecting their investment, minimizing losses, and ensuring compliance with state and federal regulations regarding borrower communication and collection practices. Professional servicing streamlines these complex and sensitive situations, reducing legal risks and administrative burden.
Usury Laws
Usury laws are state-specific regulations that set the maximum legal interest rate that can be charged on a loan. These laws are designed to protect borrowers from predatory lending practices. While federal laws might preempt state usury limits for certain types of institutional loans, private mortgage and seller financing transactions are often subject to state usury limits, which can vary significantly. For private mortgage lenders, brokers, and investors, understanding and complying with the usury laws in the relevant jurisdiction is paramount for ensuring the legality of the loan terms, avoiding severe penalties, and streamlining regulatory compliance to protect the enforceability of the promissory note.
Non-Recourse Note
A non-recourse note is a loan agreement where the lender’s recourse for default is limited solely to the collateralized property, and the borrower is not personally liable for any deficiency if the sale of the property doesn’t cover the full outstanding debt. In contrast, a recourse note allows the lender to pursue the borrower’s other assets to recover any remaining debt after the collateral is sold. Non-recourse loans are less common in private residential mortgages but can be found in commercial or specific private equity real estate deals. For private mortgage investors, understanding whether a note is recourse or non-recourse is fundamental for assessing risk and defining potential recovery options in case of default, influencing valuation and servicing strategies.
We hope this glossary provides clarity on key terms in private mortgage and seller financing. Navigating these specialized areas requires precision and expertise.
To learn more about how to simplify your private mortgage servicing and ensure compliance, we invite you to visit NoteServicingCenter.com. You can also contact Note Servicing Center directly to discuss how our professional services can streamline your operations and protect your investments.
